Morningstar Canada tool offers insights on tax-efficiency of funds

(January 28, 2004) Morningstar Canada is offering a new tool designed to demonstrate the effects of holding any given fund within an RRSP, versus holding it in a non-registered account.

Added to the usual Morningstar performance report is a tax-adjusted return, showing just what effect the various taxes applied to the fund have on the total returns. The new tool identifies whether the fund is subject to the dividend tax rate or interest tax rate.

On top of Morningstar’s well-known five-star rating system, the firm now offers a tax-adjusted rating. The new rating is still on a one-to-five scale, but may differ from its star rating because the returns are tax-adjusted.

The new tax tools apply only to mutual funds, excluding segregated funds because of the differences in reporting methods. Because every investor faces a different tax situation, the Morningstar application uses a worst-case scenario to calculate tax-efficiency of funds.

Newfoundland and Labrador’s tax rates were used as the benchmark, with rates of 48.6% for interest, 37.3% for dividends and 24.3% for capital gains. The good news is that for most investors, results will be better since that province has the highest tax rates.

“This methodology shows that a mutual fund investor’s own after-tax returns will fall somewhere between the after-tax returns reported by Morningstar and the fund’s pre-tax return,” says Mark Warywoda, Morningstar Canada’s director of analysis. “This would not be possible if other rates — such as median tax rates — were used. Based on your own marginal tax rates and specifics of your personal tax situation, you and your advisor will need to make your own judgments as to where your own after-tax returns are likely to fall.”

To check out the new offering, visit www.morningstar.ca.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com